Community Property

07/21/2016

Whether you are a fan or not, it’s best to be fully aware of what living in or moving to a community property state may mean for you and your spouse.

In most states, property owned by one member of a marriage is considered separate property owned by the individual spouse. That includes businesses, real estate owned in your name alone and other assets. This is because the laws of these states treat married couples as financially unrelated to spouses except for assets that are owned jointly or specified by wills or other estate planning documents. In community property states, it’s a different ballgame. If you live in a community property state or if you happen to move to one, you need to know how this impacts your assets.

Barron’s article, “How Community Property States Are Different,” explains that Arizona, California, Idaho, Louisiana, Nevada, New Mexico, Texas, Washington and Wisconsin are the states in which everything you acquire during a marriage is considered legally owned by both spouses. For example, their state statutes view a couple as the co-owners of a business with a 50-50 partnership.

Here are a few other issues to consider.

Premarital assets. Typically, any wealth acquired before the marriage and any inheritances acquired at any time by one spouse are not the property of the other spouse. If you intend to keep them separate, leave them out of your community accounts created after the marriage. If you want to join finances, an estate planning attorney can help you with pre- and post-marital agreements and community property agreements to pool assets.

Estate plans. In most states, a married couple’s assets are divided evenly in life, and the same is true when one dies. One half the couple’s assets become part of the estate, which can make for major taxes in some situations. If a couple buys a home for $1 million, which then appreciates to $5 million, half of the value of the home—or $2.5 million—becomes a part of the decedent spouse’s estate. It’s given a step-up in basis—a readjustment of the value of the home to the market price over what was initially paid. But the surviving spouse keeps the original cost basis of $500,000. If that spouse wanted to sell the property upon the death of the spouse, he or she would have a cost basis of $3 million (the $500,000 cost basis plus the adjusted basis of $2.5 million) amounting to a $2 million capital gain.

Community property states are a plus in this case because they give a step-up in basis to the entire home. In this example, the surviving spouse will also get a step-up in basis, which means if he or she sells the home there would be no capital gains tax owed. However, the step-up in basis can complicate wealth transfer planning.

Gifting. In community property states, both spouses have to agree on gifts from joint funds. No one can make a gift of your property without your consent, and without that consent, the spouse who didn’t make the gift can revoke the gift at a later date. It’s best to make sure it’s in writing—even when it’s a gift to each other.

Life insurance. Talk with an experienced estate planning attorney before you create an irrevocable life insurance trust. For example, a husband creates an irrevocable life insurance trust to benefit his wife, and the trust buys a $10 million life insurance policy on his life. He will need to be certain that any gifts made to the trust and used to pay the premiums are paid for from a non-community property account—payments cannot come from a joint account. Otherwise, it places a portion of the trust into the estate of his wife, which defeats the purpose of having an irrevocable life insurance trust in the first place and subjects it to an estate tax. Sign a transmutation agreement, which makes the gifts to the trusts entirely one person’s.

If this issue concerns your family, it is recommended that you meet with an estate planning attorney who has experience in community property law. You may need an agreement to preserve the community property state of assets acquired in another state, or you may wish to conserve joint trusts to prevent them from becoming comingled with assets in the new state. Community property laws are a mixed bag, and whether or not they work in your favor depends upon your own individual situation. An attorney will be able to help you achieve your goals.